Yale University has completed an independent review of Medtronic’s (NYSE:MDT) Infuse bone graft and two independent analyses have suggested that it doesn’t show significant benefits over conventional spine surgery. [1] Worse, it may lead to serious side-effects including cancer and sterility in men. [2]

The studies were initiated in 2011 after a series of articles in the Spine Journal alleged that Infuse poses greater risks than reported earlier to the FDA and that many doctors were paid/bribed to under-report these risks. This was followed by a Senate report, which stated that a number of studies promoting Infuse were likely biased, as they were edited/written by Medtronic employees. Infuse sales have been rapidly declining since then and have weighed on Medtronic’s market share in the Spinal division.

Medtronic currently commands over 30% share in the $10 billion spinal market, substantially below the 40% it held in 2008. While a positive outcome in these studies would have helped Medtronic stem the decline in Infuse sales, the latest findings may put further pressure on Infuse. The Infuse bone graft still constitutes a significant portion of overall revenues from the division even as its annual sales dropped from around $900 million in 2011 to nearly $500 million in 2012. We, however, don’t see a major impact on our current expectations and price estimate as we have already incorporated a continued decline in Infuse sales in our model.

Going forward, we expect overall revenues in the Spinal division to decline in the near term before getting back on track with the help of new products. Medtronic will continue to concede market share before seeing stabilization as growth in the spinal market is likely to outpace the division’s growth due to innovative products from competitors.

While the spinal market is expected to see annual growth of 4-6% over the next five years, the growth will be driven more by new technologies for vertebral compression fractures (VCFs) and partial and total disc replacement rather than traditional surgical techniques like spinal fusion. [3] In VCFs, kyphoplasty products are likely to see higher growth than vertebroplasty. [2] Initially, Medtronic was well-positioned to tap the expected growth in VCFs with its Kyphon balloon kyphoplasty, a vertebral augmentation product. However, the entry of companies like Stryker and CareFusion has challenged the company’s dominant position in the market. [4] This, coupled with pricing pressure from hospitals, has been weighing on its revenues as well as market share.

While Medtronic has a presence in the disk replacement market with its Prestige cervical disk, its portfolio is not as vast as some of its competitors like Johnson & Johnson’s. A few years back, Medtronic had to dump plans to roll out its Maverick, A-Mav and O-Mav artificial disk products following a patent infringement litigation with Synthes, now part of Johnson & Johnson (NYSE:JNJ). Synthes, acquired in 2012, has brought JNJ a wide portfolio of medical devices for the trauma and spine market. This is likely to put pressure on other leading players in the spinal market, including Medtronic.

The continued adoption of Solera and the Atlantis Vision Elite cervical plates, however, will continue to lend some support to Medtronic. Further, biologic products like Magnifuse and Grafton, which were added to Medtronic’s portfolio pursuant to the acquisition of Osteotech in 2010, are also seeing consistent growth. Additionally, Medtronic recently expanded its Vertex reconstruction system and launched several new products like the Bryan ACD Instrument Set, AMT implant and Capstone Control, which should help offset the decline in sales of its key products. While these products may drive revenue growth, none is likely to lift Medtronic’s market share.

To boost growth, Medtronic acquired Chinese medical device maker China Kanghui Holdings in November 2012. China Kanghui has a diversified portfolio of orthopedics, spine, and surgical instrumentation products along with strong local R&D and cheap manufacturing operations. China Kanghui had estimated annual sales (including spinal and surgical technology products) of $327 million and profit of $19 million in 2011, its last full year of independent operations. Medtronic, with its wide sales network combined with cheap manufacturing capabilities of China Kanghui, could achieve cost savings as well as higher sales. However, it remains to be seen if Medtronic will be able to capitalize on the opportunity. The company previously had some issues integrating Kyphon after spending $4 billion for the company. [5] We, therefore, are not too bullish on the acquisition for now.

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